Flood Insurance:

FEMA's Rate-Setting Process Warrants Attention

GAO-09-12: Published: Oct 31, 2008. Publicly Released: Dec 1, 2008.

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Questions about the financial status of the National Flood Insurance Program (NFIP) have increased since the 2005 hurricanes, which left the program with an unprecedented $17.4 billion deficit--a debt that resulted in GAO placing NFIP on its high-risk list in March 2006. Among the concerns are the subsidized rates NFIP must provide for about 25 percent of the policies, mostly for older buildings in high-risk flood zones. And although fully risk-based rates are supposed to reflect actual flood risk, concerns have been raised that they do not. This report evaluates (1) the Federal Emergency Management Agency's (FEMA) process for setting full-risk rates to determine whether it produces rates that accurately reflect the risk of flooding and (2) the process that FEMA uses to set subsidized rates and their effect on the financial condition of NFIP. To do this work, GAO evaluated the NFIP rate model, examined data from FEMA, surveyed relevant literature, and interviewed other relevant agencies and risk-modeling firms.

FEMA's method for setting its full-risk rates may not ensure that the rates accurately reflect the actual risk of flood damage. The NFIP model combines estimated flood risk with expected flood damage, but a number of factors may affect the accuracy of the rates the model generates. First, some data inputs are outdated or inaccurate. FEMA relies on flood probabilities from the 1980s and damage estimates that do not fully reflect recent NFIP damage experience. Moreover, while FEMA has made updating its flood maps a priority, most of the maps used in rate setting have not yet been updated. Second, FEMA does not require all properties remapped into higher-risk areas to pay rates based on the new designation. This policy, known as grandfathering, erodes NFIP's ability to charge rates that reflect the risk of flooding. The policy is intended to increase participation, but FEMA does not track the number of grandfathered properties and cannot determine their financial impact on the program. Third, FEMA uses a nationwide rating system that combines flood zones across many geographic areas, so individual policies do not always reflect topographical features that affect flood risk. In fact, some patterns in historical claims and premium data suggest that NFIP's full-risk rates may not always reflect actual flood risk. Collectively, these factors increase the risk that premiums collected on full-risk policies may be insufficient to cover future losses, adding to concerns about NFIP's financial stability. FEMA's rate-setting process for subsidized properties depends in part on the accuracy of the full-risk rates, raising concerns about how these rates are calculated as well. To set subsidized rates, FEMA first subtracts the total amount it expects to collect in full-risk premiums from the average historical loss year--that is, the minimum (target) amount that the program needs to collect from all premiums to cover at least average annual losses, as determined by historical data. The remainder becomes the aggregate target amount the program must collect in subsidized premiums. To set individual subsidized rates, FEMA officials then consider their knowledge of flood risk, previous rate increases for various locations, and statutory limits on increases. The resulting subsidized premiums continue to be a financial strain on the NFIP and contribute to its ongoing financial instability. Evidence suggests that flooding is likely to become more severe in the future, resulting in increased risk exposure, the potential for more catastrophic losses, and ongoing financial instability for the program. Currently, the annual amount that NFIP collects in both full-risk and subsidized premiums is not enough to cover its operating costs, claim losses, and principal and interest payments to the Department of the Treasury, thereby exposing the federal government and ultimately taxpayers to ever-greater financial risks, especially in years of catastrophic flooding.

Recommendations for Executive Action

  1. Status: Open

    Comments: As of January 2017, FEMA is taking steps to verify the accuracy of flood probabilities by collecting and analyzing data from flood insurance studies. FEMA is also continuing to monitor the completion of these studies to determine when a statistically valid amount of data is available so that it can better assess flood risk. To verify the accuracy of damage estimates, FEMA is collecting data required to revise its estimates of flood damage and is undertaking studies to determine factors beyond flood water depth that contribute to flood damage. FEMA will incorporate that information into its rate-setting methodology as the necessary data becomes available. To verify the accuracy of flood maps, FEMA continues to reassess flood risk, evaluate coastal flood maps, and update its overall map inventory. To ensure that flood probabilities reflect long-term and ongoing planned development and climate change, FEMA is working with the Technical Mapping Advisory Committee to ensure the best available information on flood probabilities is used for rate-setting. In addition, as FEMA collects information on flood probabilities, it will conduct analyses to evaluate the practice of classifying risk across zones.

    Recommendation: The Secretary of the Department of Homeland Security should direct FEMA to take steps to ensure that its rate-setting methods and the data it uses to set rates result in full-risk premiums rates that accurately reflect the risk of losses from flooding. These steps should include, for example, verifying the accuracy of flood probabilities, damage estimates, and flood maps; ensuring that the effects of long-term planned and ongoing development, as well as climate change, are reflected in the flood probabilities used; and reevaluating the practice of aggregating risks across zones.

    Agency Affected: Department of Homeland Security

  2. Status: Open

    Comments: To assess the impact of grandfathered properties on the NFIP, as of January 2017, FEMA has begun to develop a process to obtain current zone designations for all existing policyholders. In addition, FEMA is requiring zone determination data to be updated as flood maps change. According to FEMA, this will allow officials to determine which policyholders are grandfathered but will not allow the determination of a property-specific rate in all circumstances.

    Recommendation: The Secretary of the Department of Homeland Security should direct FEMA to ensure that information is collected on the location, number, and losses associated with existing and newly created grandfathered properties in NFIP and to analyze the financial impact of these properties on the flood insurance program.

    Agency Affected: Department of Homeland Security


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